Lawrence O’Donnell commented on Medicare reforms in Obama’s State of the Union speech. He seemed to imply that Obama was shifting from “fee for service”, the current model, to “capitation”, or HMO model. That is neither what Obama said nor implied.

What the Affordable Care Act (ACA) promotes is not the HMO or capitation model, but “payment for results”. This is something of a hybrid of “fee-for-service” and “capitation”. Fee-for-service IS unsustainable while a Medicare HMO would put the entire cost risk on the providers — both the risk [1] for the cost of each incident AND [2] for the frequency of incidents. That is too much risk for Providers. But there is a middle road.

“Payment for results” in the ACA “constrains” the cost for an incident but for NOT the frequency of incidents. So if twice as many seniors got the flu, providers would receive flu reimbursement for each senior treated. Just as occurs now, there is no added risk to providers if more people get sick or injured.

What changes is the reimbursement for an individual incident. “Payment for results” ends the one-for-one fee-for-service where hospitals and doctors are reimbursed a dollar for every eligible dollar billed.

However, Medicare’s “results” payments would apply only to combined groups of hospitals and doctors called “Accountable Care Organizations” (ACO). To encourage formation of ACO’s, ACA offers a carrot. If the ACO members working together can treat, for example, a flu incident for less, Medicare will first pay the ACO that lower cost but it will also share with the ACO the savings between billed cost and an imputed fee-for-service cost. Further, Medicare would make one combined payment to the ACO and not be involved in how the ACO divides that payment between hospitals and doctors.

Along with the carrot is a stick. If the ACO over-treated (higher cost) or mistreated that led to a relapse (poor result) and additional treatments, the ACO would not get reimbursed the full amount for these “extra” services. The ACO’s have a two-edged incentive to become more efficient.

With fee-for-service, efficient providers that bill less are paid less. Medicare keeps ALL the savings, so why should providers bust their butts to lower costs. Under ACA these ACO providers now get to share in the savings. This idea is not only good for providers and Medicare, but the entire health insurance industry. Providers are rapidly forming ACO’s across the country, not just for Medicare patients but for the entire population. Even some insurers are forming ACO’s, becoming both the insurer and provider.

For decades, hospitals or doctors have competed somewhat “softly” in that you never see price wars between providers. The business model of for-profit insurers closely mirrored the “cost-plus” model of some military contracts that led to $600 toilet seats. Insurers had limited incentive (or success) to put heavy pressure on providers. Instead, insurers spent more time cherry picking their membership to reduce claims instead of constraining provider costs.

Under ACA’s prohibition of excluding people with pre-existing conditions, insurers will no longer be able to cherry pick their membership. To compete, they will have to focus more attention on lowering provider costs. Hence, their incentive is also to promote ACO’s.

Finally, the ACA made payment for results a pilot program since this model is untested in the United States. Not being mandatory, the CBO has not factored in any savings arising from this program. The savings could be substantial and we have some evidence that savings will occur.

One analyses on this site, “Medicare – Fewer Benefits or Less Waste” compares Mayo Clinic’s all-in costs versus the highest cost 20% of hospitals. Mayo’s prices are higher than industry average, but their intensity was lower (fewer days, fewer treatments). If the 20% highest cost hospitals had costs comparable to Mayo’s, the savings could exceed $250 BIllion over 10 years. A significant savings indeed.